While arbitration clauses are often a topic of concern in the consumer context, they can also be a major issue in sophisticated party transactions as well—the agreements where the arbitration clause is the least of everyone’s worries. In these transactions, whether they be in the employment context or otherwise, arbitration clauses are often treated as a throwaway for which a simple copy-and-paste will do. At that forward-looking time, arbitration seems like a sensible method of dispute resolution between two like-minded people, and it is given little emphasis. When the relationships break down later, as they often do, arbitration clauses become a major issue. Too often, one side wants to be in court while the other does not. They argue whether their dispute is subject to arbitration.
Arbitrability of a claim has been discussed and debated at length. There are many excellent articles relating to arbitrability; the question that asks whether a claim should be arbitrated per the parties’ agreement or litigated in court. Before the arbitrability question is addressed, there is another question that must be answered first: Who decides the arbitrability question? The court or the arbitrator? Depending on who answers the question, the outcome could be different as arbitrators have strong financial incentives to have the dispute before them.
Delegation clauses, which gives arbitrators, rather than the court, the authority to determine arbitrability, can cause your client to be forced to submit to arbitration for claims extremely attenuated from the parties’ agreement that were never anticipated as being covered. Certain U.S. Courts of Appeal have addressed this problem by allowing the court to decide arbitrability even where there is a delegation clause when the arbitration claim is “wholly groundless.” Other circuit courts have recently rejected this solution, leading to a Circuit split on the legality of the wholly groundless exception. The U.S. Supreme Court is set to decide this issue, along with two other arbitration-related issues, in the upcoming term.
What Is a Delegation Clause?
A delegation clause is a provision in the arbitration clause that specifies that the arbitrator, rather than the court, decides questions of scope and arbitrability of any claims. Under the Federal Arbitration Act, 9 U.S.C. Section 1, et seq. (FAA), as interpreted by the Supreme Court, there is a long-standing general presumption that the issue of arbitrability should be resolved by the court, not arbitrators, see First Options of Chicago v. Kaplan, 514 U.S. 938, 944-45 (1995). This means that if an arbitration clause is silent on who determines the arbitrability of any potential claims, the court decides. In recent years, and in line with the pro-arbitration movement, the courts have limited this general presumption. For instance, the circuit courts unanimously agree that the issue of arbitrability may only be referred to the arbitrator, rather than the court, only if there is “clear and unmistakable evidence” from the arbitration agreement that the parties intended the question of arbitrability to be decided by the arbitrator. See, e.g., General Electric v. Deutz AG, 270 F.3d 144, 154 (3d Cir. 2001).
“Clear and unmistakable,” however, does not mean what the phrase suggests. Almost every circuit court has determined that the mere incorporation of the AAA or JAMS rules by reference satisfies the requirement of “clear and unmistakable evidence” that the parties (in a nonclass action settings) intended to have an arbitrator decide threshold issues of arbitrability. See, e.g., Contec v. Remote Solution, 398 F.3d 205, 208 (2d Cir. 2005). This is because these rules provide for the arbitrator’s authority to determine jurisdiction and arbitrability issues as a preliminary matter. See, e.g., Rule 8(b), JAMS streamlined arbitration rules & procedures (Effective July 1, 2014).
Although the U.S. Court of Appeals for the Third Circuit has not explicitly decided whether incorporation of the AAA or JAMS rules by reference is “clear and unmistakable” evidence, the district courts within the Third Circuit that have addressed this question have followed the prevailing rule that incorporation by reference of rules granting the arbitrator the authority to decide questions of arbitrability is clear and unmistakable evidence that the parties agreed to submit arbitrability questions to the arbitrator. See, e.g., Way Services v. Adecco North America, 2007 WL 1775393, at *4 (E.D. Pa. June 18, 2007). This means standard language such as “any controversy … shall be determined by arbitration held in Philadelphia, Pennsylvania in accordance with the Commercial Rules of the American Arbitration Association” is all that is needed for a party to forego having a court determine arbitrability.
Why Does It Matter Who Determines Arbitrability?
While AAA and JAMS arbitrators are certainly competent to determine the arbitrability of claims, this decision poses an inherent conflict for them that judges do not face. Arbitrators have a financial incentive to retain jurisdiction over claims when it is questionable whether they are arbitrable. By submitting the issue of arbitrability to an arbitrator in the first instance, there is a risk that an arbitrator will err on the side of finding claims arbitrable in what is often a complex legal analysis (and a topic for another article) in which there are justifications for either result.
While there are many pros to arbitration, such as secrecy and expediency, there are also cons. First, arbitration can be remarkably expensive, particularly where an arbitration agreement provides for a panel of arbitrators rather than just one arbitrator. The cost of a panel of arbitrators alone could be $3,000 per hour, or more. While arbitration fees are often split between the parties 50/50, arbitration can still be a heavy price for a client, especially when they are already paying hourly attorney fees.
Second, arbitrations are not governed by the discovery rules of the rules of civil procedure. The amount of discovery permitted in an arbitration, particularly where the cost of resolving any disputes carries a price tag of $3,000 per hour, is substantially less than in court. Often there are no depositions, including party depositions. The ability to obtain third-party discovery is slim to none in arbitrations. For the client searching for truth and justice, as opposed to a speedy compromise, this limitation can cause arbitration to miss the mark.
The Legality of the ‘Wholly Groundless’ Exception
The current state of the law leads to preposterous situations in which an arbitrator, rather than the court, is determining the arbitrability of claims that are facially (or clearly) nonarbitrable, whether it be because the contract is narrowly limited in scope, there is a superseding contract, or the party being hauled into arbitration never even signed an arbitration agreement. To help fix this problem, the Federal Circuit Court of Appeals, followed by the Fourth, Fifth, and Sixth Circuits, and various district courts in the Ninth Circuit, adopted the wholly groundless exception to delegation clauses. See, e.g., Qualcomm v. Nokia, 466 F.3d 1366, 1371 (Fed. Cir. 2006). Under this carve-out, the court does a “spot check” in the first instance to determine whether there is any plausible pro-arbitration argument. Arguments of arbitrability must pass this smell test to get past the court to the arbitrator. If the court determines that a claim is clearly outside the scope of arbitration clause, the court will retain jurisdiction of the claim.
Last year, however, the Tenth Circuit, followed by the Eleventh Circuit, rejected the wholly groundless exception, finding it to conflict with the Supreme Court’s arbitration decisions. See Jones v. Waffle House, 866 F.3d 1257 (11th Cir. 2017); Belnap v. Iasis Healthcare, 844 F.3d 1272 (10th Cir. 2017). On June 25, the Supreme Court granted certiorari in the matter of Henry Schein v. Archer and White Sales, No. 17-1272, on appeal from the Fifth Circuit to determine the issue of “whether the FAA permits a court to decline to enforce an agreement delegating questions of arbitrability to an arbitrator if the court concludes the claim of arbitrability is ‘wholly groundless.’”
Given the Supreme Court’s decision in the consolidated three cases of Epic Systems v. Lewis, No. 16-285; Ernst & Young v. Morris, No. 16-300; and NLRB v. Murphy Oil USA, Inc. (16-307), wherein it held, in a 5-4 decision, that arbitration agreements requiring individual arbitration proceedings and waiving the right to participate in class or collective actions are lawful and enforceable under the FAA, regardless of allowances set out within the NLRA, it seems unlikely the high court will endorse the wholly groundless exception.
Given the power the incorporation of the AAA or JAMS rules in arbitration clauses carries, lawyers drafting arbitration clauses should help their clients decide who they want to decide questions of arbitrability. If a client wants to preserve the issue of arbitrability for the court—to ensure that only arbitrable claims are referred to arbitration—the arbitration clause should explicitly state such (e.g., “Any and all issues regarding the scope, validity, conscionability and applicability of an arbitration clause must be decided by a court.”). Under this scenario, a court will determine the arbitrability of all claims, giving your client the best chance at arbitrating only those claims anticipated when the agreement was executed.
Edward T. Kang is the managing member of Kang Haggerty LLC. He devotes the majority of his practice to business litigation and other litigation involving business entities.
Kandis Kovalsky, an associate at the firm, focuses her practice on representing both corporate and individual clients in a broad range of complex commercial litigation matters in Pennsylvania and New Jersey state, federal and bankruptcy courts.
Reprinted with permission from the July 26 edition of “The Legal Intelligencer” © 2018 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or email@example.com.